(OFFICIAL)-Brazil payments processor Cielo struggles against upstarts

SAO PAULO, Sept 28 (Reuters) - Brazilian payment processor Cielo SA's once fat margins have been decimated by rivals who lease or sell credit card terminals to merchants for a fraction of what the market leader has long charged.

Now Cielo is fighting back, offering services such as inventory management and market intelligence tools to justify its premium pricing and retain its core payments clients, two sources close to the company said.

The company, Brazil's dominant payment processor, has its work cut out for it. At the end of June, the number of merchants using Cielo's payment systems was down almost one-fifth from a year ago to 1.1 million. And its shares, which once reliably outperformed Brazil's benchmark stock index, have plunged 43 percent this year.

Cielo has been struggling even as Brazilian credit and debit card transactions surged 14 percent in the first half of 2018, according to industry association Abecs.

The cozy duopoly Cielo shared with rival Rede - owned by Itaú Unibanco Holding SA - has been shattered as the two have respectively lost exclusive rights to process Visa and MasterCard transactions in Brazil.

Sao Paulo restaurant owner Sidney Tadeu Prado is just the kind of client Cielo is battling to keep. For nearly two decades, he had to lease two different payment terminals, one from Cielo for Visa and another from Rede for MasterCard, each costing him roughly 150 reais per month.

Then last year, Stone Pagamentos SA, a company Prado had never heard of, offered to lease him a single terminal for both Visa and MasterCard payments for 40 reais a month. He has already returned Rede's machine and will soon do the same with Cielo's.

PRICING TRANSPARENCY

The two sources said Cielo aims to mostly hold the line on prices despite the onslaught from Stone and another upstart, Pagseguro Digital Ltd. Instead, it hopes to retain clients by, for example, offering analytics tools for their own businesses as well as their neighborhood competitors.

For Prado, at least, that was not enough.

"The difference in prices charged is huge just to get information about a clientele I have known for almost 20 years," he said.

Merchants can now search via the web for the cheapest prices and fees for card transactions and terminals, conferring a new-found pricing transparency in Brazil's payment processing sector.

Still, Cielo is aggressively pushing a more advanced, smartphone-like Lio payments terminal, which companies can connect to their own inventory, payroll and accounting systems, an integration that could make them more reluctant to switch to other payments providers.

Lio client numbers have surged to 100,000 from 8,000 in one year, but they still represent a fraction of Cielo's overall business.

In its latest bid to protect its margins and expand its customer base, Cielo last week launched a detachable card machine reader that connects to the back of a mobile phone, dubbed Lio+. Merchants using this new device will pay higher than average transaction fees from the outset.

The launch did little to dent investor gloom.

NAIL SALONS

"We believe the product's appeal will be limited, given the price point, the limited flexibility around the mobile phone associated with it, and the array of options available from competitors," Goldman Sachs analysts said in a recent research note.

Cielo has lost 25.6 billion reais ($6.4 billion) in market value this year and is now worth 34.2 billion reais, about the same as its rival PagSeguro, which went public in January and whose transactions amount to a bit more than 10 percent of Cielo's.

PagSeguro, which sells its card reading devices instead of leasing them, primarily targets smaller merchants - street vendors, nail salons, cab drivers and others who only recently started working with credit cards. It is also seen as having more potential to grow than Cielo, for example, by offering its clients banking products and services.

Those inroads into a new cohort of merchants helped prompt Cielo's acquisition earlier this year of Stelo, a startup that, like PagSeguro, lets small merchants buy card reader machines rather than rent them.

With the acquisition, Cielo will be competing on price in one portion of the market, at least. ($1 = 4.0127 reais) (Editing by Christian Plumb and Steve Orlofsky)